No matter what kind of business you’re in, you’ll likely have to decide whether to lease office space or buy a building.
“The pros for buying an office building are similar to the rationale when deciding to rent or purchase a home,” says Patrick Burns, business banking vice president at Plano-based ViewPoint Bank. “Similar to home ownership, owning the building in which your business resides requires serious considerations. These include future price appreciation, cash flows and down payment costs.”
Smart Business spoke with Burns regarding the benefits of owning your own building versus staying in your lease.
Are there certain types of industries or business circumstances that make it more advantageous to lease space rather than buy?
Yes, there are. It’s typically a disadvantage to buy when a business has sales under $250,000 a year. Banks require the debt service coverage ratio to be 1.25 cents on the dollar. Therefore, if you have a $5,000 mortgage payment per month, the bank will want to see cash flow of $6,250 or more in order to cover the mortgage payment. In other words, your cash flow needs to exceed payments by 25 percent.
Other businesses better off leasing are start-up service businesses, such as attorneys or other professionals. These young professionals are usually saddled with higher education debt and don’t have the cash flow or savings to make a down payment on a building. Also, there are many other attractive options such as leasing an executive suite with an assistant. It is best for these businesses to get a few years under their belts before purchasing a building.
Another reason to continue leasing is to allow your business to be scalable. Companies that own buildings and are letting employees go can have a more difficult time and may have to either sell the building or sublease the extra space. Those renting will simply need to pare down their office space.
When should a business owner make the decision to buy a building?
The best time to purchase a building is when a business owner has a good cash flow and money in the bank to make the down payment necessary for the purchase. For example, if a building is selling for $500,000, the owner will need to put 20 percent down or $100,000. Do you have that kind of cash, plus some left over for cash reserves? The answer should be ‘yes’ in order to approach a bank for a commercial mortgage loan.
Also, a business has to have a strong positive cash flow to make the mortgage payment and cover taxes, insurance and maintenance costs. That said, tax deductions and appreciation can make this overall monthly cost less of a burden than renting. For example, if a business owner is paying $5,000 a month leasing office space, it is comparable to a $523,000, 15-year 8 percent mortgage payment. If a business owner finds a building that costs $500,000 and puts $100,000 down, it will be a $400,000 loan. The monthly payment would be approximately $3,800, equivalent to $1,200 a month in savings. When the business owner deducts interest and other costs, the monthly out-of-pocket expense to own the building is even less.
Are there other advantages to purchasing?
Yes, buying a building automatically gives you a second business in real estate investing. This is particularly advantageous to small business owners who may need the perks accompanying ownership that large companies have, such as 401(k) programs. The building loan, as it decreases in debt, can be viewed as a retirement savings vehicle for the owner. Also, there are a variety of options available to the business owner at retirement. These might include selling the office building, providing a lump sum benefit upon the sale and leasing the space, which provides a stream of income. Another advantage has to do with the business owner’s American dream: to see a building with his or her name or business name above the doorway. Of course, owning the building as a financial property is the largest perk; however, there is a lot of pride in owning a building on which you can’t put a price tag.